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Does Your Second Home Qualify for a Tax-Deferred 1031 Exchange?

IRS - 1031 tax deferment on vacation homeCan a vacation 2nd home qualify for a 1031 tax deferred exchange? The answer is an unequivocal "maybe." Clear enough? There certainly are established tax breaks that can make a vacation home more affordable, and use of this knowledge is how tax specialists earn their daily bread. I strongly suggest you meet with one for the latest IRS rulings and to maximize your benefits. One very basic rule is to document the length of time per year that you and your family members spend at your vacation home, and whether it is held for personal use and enjoyment or for investment purposes. This, along with any rental income you may derive from it, will determine how the property is treated for tax purposes. The three basic categories for review are: Use a lot/Rent a lot; Use a little/Rent a lot; and Use a lot/Rent a little.

What qualifies for a 1031 exchange?

It is accepted that a 2nd property that is used fewer than 14 days per year by the owner and rented out the rest of the year, is considered to be an investment property and qualifies for a 1031 exchange. Furthermore, raw land with no improvements and held solely for appreciation purposes qualifies for a 1031 exchange. Again, this at times may seem like a somewhat moving target, and discussion with your tax advisor would be my advice. If your 2nd home is used exclusively for family vacations, the interest on a mortgage would be deductible just as interest on your first home is treated. And as important, local property taxes may be deducted on your second home. If your 2nd home is for seasonal use only, and you rent it out for 14 days or less in a calendar year, you can receive rent without claiming it on your income tax return. You can also still claim the same deductions in that the IRS considers it to be a vacation home. Some formerly seasonal homes, bought many years earlier, and then later used as the principal residences of newly retired owners following improvements, may qualify for the up to $500,000 tax free profit upon its sale after 2 years of primary use. However, federal legislation has been adjusting this break recently to apply tax to a pro-ration of the total years of 2nd home ownership to that of primary residence. Confused? It is daunting at times, but 2nd home ownership reality is made more possible for many by navigating through the existing rules and regulations - and for, by and large, very enjoyable results. Jim Ferriman
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